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Financial audits reasons behind failures & some suggestions

  1. (C) copyright 2017 Kumar Indra Mohan 1
  2.  Auditing is the independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a view to expressing an opinion thereon.  A financial audit is conducted to provide an opinion whether "financial statements" (the information being verified) are stated in accordance with specified criteria. Normally, the criteria are accounting standards, although auditors may conduct audits of financial statements prepared using the cash basis or some other basis of accounting appropriate for the organisation. (C) copyright 2017 Kumar Indra Mohan 2
  3.  In providing an opinion whether financial statements are fairly stated in accordance with accounting standards, the auditor gathers evidence to determine whether the statements contain material errors or other misstatements.  The auditors are playing role as watchdogs to help the shareholder monitor the credibility of the information presented by the management and verification of financial statement if showing true and fair view to the shareholder. It enhances credibility and the perception of the external stakeholders when the external auditors express their opinion as impartial and without conflicts of interest.  Due to above the function of audit is also termed as “ Financial Policing” sometimes. (C) copyright 2017 Kumar Indra Mohan 3
  4. 1. Audit Helps to Detect and Prevent Errors and Frauds An auditor's main duty is to detect errors and frauds, preventing such errors and frauds and taking care to avoid such frauds. Thus, even though all organizations do not have compulsion to audit, they make audit of all the books of accounts. 2. Audit Helps to Assess Tax Tax authorities assess taxes on the basis of profit calculated by the auditor. In the same way sales tax authority calculates sales tax on the basis of sales shown in the audited statement. 3. Audit Helps to Maintain Account Regularly An auditor raises questions if accounts are not maintained properly. So, audit gives moral pressure on maintaining accounts regularly. (C) copyright 2017 Kumar Indra Mohan 4
  5. 4. Audit Facilitates to Compare & analyse An auditor instructs an accountant in the same way which helps to compare books of accounts of current year with the accounting of the previous year. So, comparing the accounts of current with previous years helps to detect errors and frauds. 5. Audit acts as deterrence for fraud perpetrators It acts as a moral check on the employees of the organisation. The apprehension of getting caught during audit forces them to keep accounts up-to-date. 6. Audit Helps to determine amount available for Dividend/Bonus. Profit from a business during the given period is certified by the auditor while auditing books of account. This in turn helps to find the amount available for distribution amongst employees/shareholders. (C) copyright 2017 Kumar Indra Mohan 5
  6. 7. Audit Helps to Present a Proof If any case is filed by/against the audited entity, audited accounts are many a time presented as a proof/evidence in the court of law. 8. Audit Provides Information About Profit or Loss A businessman wants to know profit or loss of his business after a certain period of time. So, the owner of the business can get information about profit or loss after auditing the books of accounts. 9. Audit Helps to Prepare Future Plan All the audited statements remain true and correct. Such true and correct account helps to prepare for the future plans. 10. Audit Helps to Increase Goodwill Auditing shows the profitability and financial position of an organization which creates faith of public over the business. Thus, auditing helps to increase goodwill of an organization. (C) copyright 2017 Kumar Indra Mohan 6
  7. All the organisations (which we own or work for) can be broadly grouped under following three categories –  Govt/Semi-Govt Departments.  Companies/ firms and  Not-for profit organisations Now if we look carefully, it may be noted that while the first group is answerable for the general well being of the society, as it is governments responsibility to provide basic amenities and infrastructure for its citizens including health, education, security and other public welfare, it largely depends on the revenue collected in the form of taxes for all this. Not to forget that there is a need for audit here also to check whether all the money is being spent properly and not being misappropriated. (C) copyright 2017 Kumar Indra Mohan 7
  8. While the govt’s world over functions as the enabler and facilitates trade and commerce by providing conducive environment/regulations, it is the second group which drives the growth of any economy/nation which in turn effects the general well being of the citizens of any nation. Thus we can understand how critical is an orderly functioning of these entities as, directly or indirectly, it effects all of us. A proper system ensuring a orderly function of these entities can never be overemphasised. (C) copyright 2017 Kumar Indra Mohan 8
  9. Not for profit organisations ( NGO’s) are gaining lots of clout/attention and have proved their worthiness in today’s world. The movement which gained attention initially few decades back with the names like Red Cross Society today rivals big multinationals in their size, geographical reach and deep pockets. Owing to their stated objectives and nature of activities, they enjoy many incentives and relaxations. This in turn invites the unscrupulous people to assume its garb for profiteering or sometimes run motivated campaigns under its shelter. Here again the role of auditors becomes significant to ensure that the sector is functioning within its laid down parameters and doesn’t become a tool for achieving ulterior objectives. (C) copyright 2017 Kumar Indra Mohan 9
  10.  Enron Corp.  Toshiba Corp  Worldcom  Lehman Brothers  B L madoff Invest LLC  DSQ Software Ltd  Satyam Ltd  Speak Asia  Saradha Chitfund (C) copyright 2017 Kumar Indra Mohan 10 Do the names listed below sounds familiar ?
  11. Corporate scandals like Enron/Toshiba and management frauds like Satyam --the fraudulent presentation of financial statements by management--has off late attracted the critical attention of the people/press globally. This in turn has raised a strong concern for the state of the system of corporate accounting, financial reporting and their effective monitoring . Also because, to a large extent, the health of the capital markets rests on the confidence that financial statements ( presented by the management and certified by the auditors) are not fraudulent. Thus, the detection and prevention of fraudulent financial statements becomes essential to the functioning of any vibrant economic system, and they must be ensured by the auditing profession and the business community. As the globe is getting more and more integrated and organisations are becoming bigger and ever more powerful (financially), the need for effective and timely regulation for them should never be underestimated. The suspected BEPS (shifting of profit from high tax region/country to lower tax region/country) accusations against the multi-national companies further indicates the need for an independent and transparent authentication of their books of accounts. (C) copyright 2017 Kumar Indra Mohan 11 The above is a sample list of global and local corporate scandals reported widely in media. In almost all of above the end result was bankruptcy and closure of company, forcing huge loss of investors/creditors money and thousands of jobs. At the same time they also raised serious doubts on the effectiveness of the present audit systems .
  12. While the each case listed above and are different in their modus- operandi and occurred at different time triggering new set of regulations, they do expose the gaps persistent in the system. While the regulators have tried to keep pace with the changing environment, there are some inherent limitations of the system - 1.The cost has no direct EVA: Testing involves extra cost to the organization which is considered as a burden. It involves operational disruptions in many cases. The auditor has to concentrate more even though there are disruptions notwithstanding the natural resistance. It is almost impossible to quantify the benefits of the process. 2. Evidence is not conclusive Audit evidence is not conclusive in nature the confirmation of debtors is not conclusive evidence that all amount will be collected, the conclusions are persuasive rather than conclusive. (C) copyright 2017 Kumar Indra Mohan 12
  13. 3. Not easy to detect some frauds It’s not easy for an auditor to detect the deeply laid frauds which involves acts designed to conceal them such as forgery, false explanation, and not recording transaction and so on. 4. All transactions cannot be checked It is not possible for an auditor to check each and every transaction; he has to check them on sample basis. 5. Rapid change in technology: There is innovation and development of advance technology which is used in the business organization so, there is risk that the auditor may not cope with latest technology and audit tools. 6. Rely on experts The auditor has to rely on experts like lawyers, engineers, valuers etc. for estimation of contingent liability and valuation of fixed assets. (C) copyright 2017 Kumar Indra Mohan 13
  14. 7. Audit cannot assure about profitability or efficiency of management Even though the accounts are audited it doesn’t mean that the user can take granted the future profitability or prospects of concern as audit don’t comment on efficiency of the management. 8. The push for Tax / Performance optimisation Most of the time an auditor is faced with one of the two auditee stance, while one group is constantly pushing to minimise its tax liability , the other one is more interested in boosting its performance report as the incentives are linked and want to meet/better market analyst projections. 9. Auditors Independence Though under the law shareholders appoint auditors but in fact it is the directors (who are majority shareholders or controlled by majority shareholders) who appoint auditors, so this raises concerns on the independence of auditors. (C) copyright 2017 Kumar Indra Mohan 14
  15. Like we have read before – auditors are also known as financial police. Now for a moment just think about the police force in your city. You must be reading about the crime reports in the newspapers daily. Does it mean that the police is not doing their job and the department should be shut down? The answer is - No. A normal response is - find the ways and means to make them more effective. Similar is the case of audit also - the need is to help the profession by removing the constraints and strengthening it with effective regulatory support. (C) copyright 2017 Kumar Indra Mohan 15
  16. Let’s look at some of the measures / suggestions which can be taken to improve the process - 1. Audit independence – The single most important aspect of the discussion as the auditor is supposed to give its findings and report on a person who appointed the firm and shall pay its fee. The underlying concept limiting the role of an auditor as a watchdog (can bark – not supposed to bite) is fine but then don’t let the dog get fed by the stranger. 2. Appointment- The very first step needed for maintaining auditors independence is, to secure his appointment or removal, from the auditee. In the absence of it, all other measures runs the risk of getting compromised however good they may sound. (C) copyright 2017 Kumar Indra Mohan 16
  17. 3. Remuneration – Renowned investor Warren Buffet once said about the auditors remuneration in his famous annual newsletter – “whose bread I eat, I will sing his song”. It is imperative that the audit fee is regulated by an independent regulator to insulate auditor from any coercive situation. 4. Rotation – It is a normal human behaviour where – “familiarity breeds contempt”. And contempt for the routine processes may prove fatal as far as the routine audit works are concerned. Just because they are repetitive in nature doesn’t make them any less effective. To avoid this situation it is necessary that a new auditor assumes the role at regular interval. 5. Restriction on non-audit services - The non-audit works from a auditee may influence an auditors judgement and estimation. It is hence advisable to bar the auditors from doing any non-audit work in order to keep him free from any undue influence. (C) copyright 2017 Kumar Indra Mohan 17
  18. 6. Follow-up action on reports - It is observed that the concerned authorities fails to take notice and required action on the basis of qualifications/observations given by the auditor in its report. This sometimes dampens the spirit of the professionals as his efforts seems futile. 7. Peer review- It helps in identifying the weak areas of any audit firm and acts as trigger for improvement thereon. 8. Knowledge updation- In the rapidly changing world where technology is making everyone obsolete, regulations change every day and organisations assume the size bigger then many nations( financially), it is a constant tread-mill running for any professional to keep himself updated. (C) copyright 2017 Kumar Indra Mohan 18
  19. 9. Independent regulator – To remove any concern from the mind of every stakeholder, it is necessary that the profession should have an independent regulator. The auditors are playing a very important role in modern day society. The duty of the auditors is to “perform the audit to obtain reasonable assurance about whether the entity maintained effective control over the financial statement”. Auditors assurance that the financial statement represents true and fair picture of organisation to the user of financial statement such as shareholder, employee, government and overall society where organization operates, is paramount in functioning of the overall system. (C) copyright 2017 Kumar Indra Mohan 19
  20. Questions Please ? ! Thank You Twitter handle : @kumarspoint (C) copyright 2017 Kumar Indra Mohan 20